In addition to the new narrative of the crypto market, the US dollar monetary policy is a key factor affecting the market trend.Especially after the passage of ETFs, btc and eth have gradually entered the asset layout of mainstream institutional investors, the market’s capital structure, attributes, and investment methods are undergoing significant changes, and cryptocurrencies are increasingly forming a certain kind of resonance or differentiation with other major asset classes such as U.S. stocks and U.S. bonds and gold.
For some time now, the market has been oscillating between interest rate cut expectations, recession expectations, and general election expectations, which essentially corresponds to capital, fundamentals, and regulation, and the three factors are intertwined and affect each other.The most direct impact is the rate cut and rate cut expectations, to a certain extent, in a small cycle, rate cut expectations in the transaction is more important than the rate cut itself, then sort out the mid-to-late September upcoming rate cut is particularly critical.
1. Why cut: deflation from high inflation, but interest rate cuts more from the labor market slowdown
Leverage divergence under high inflation in the U.S.: Government leveraging and residents deleveraging to support U.S. economic resilience.There is not much disagreement in the market about the cause of high inflation, and the overly aggressive fiscal policy of the United States in recent years is the core reason.Aggressive fiscal put a lot of liquidity to the market at the same time, on the one hand, the Fed’s rapid expansion of the table, the government deficit grew significantly; but at the same time, on the other hand, the resident sector and non-financial corporate sector liabilities did not grow significantly, but rather improved.
Chart: U.S. Leverage Ratio Diverges Across Three Sectors, Residential Leverage Ratio Declines
The leverage divergence further explains that although the 10-year and 2-year spreads on U.S. bonds, a forward-looking indicator of recession, inverted from July 2022 and remained inverted for a total of 26 months, the longest period in history, until August of this year, when a slowdown in the labor market and expectations of interest rate cuts led to a decline in short-end interest rates, which led to a further lifting of the inversion, a recession was not yet on the horizon.
Chart: U.S. bonds inverted for the longest time in history, exacerbating market fears
The data does not support a recession, but a slowing labor force and deteriorating data quality are reinforcing expectations for a rate cut and raising recessionary concerns.In terms of inflation, the current PCE (2.5%) and core PCE (2.6%) have not reached the Fed’s target of 2%, but Wall Street traders generally expect the Fed to cut interest rates in September. In addition to Powell and Fed officials continuing to make dovish noises to the market, there is also an important backdrop is that in the Fed’s monetary policy framework in 2020, the original inflation targeting system was changed to an average inflation targeting system.The average inflation targeting system, at the same time, although employment and inflation is still the Fed’s main balance between the two goals, but employment and labor market is significantly raised in the priority position.In other words, the Fed is more inclined to tolerate short-term high inflation, so as to ensure the stability of the labor market.
Changes in the monetary framework are further reflected in each of its FOMC meetings and management of market expectations, non-farm payrolls, unemployment rate and other data released each time will trigger repeated market turbulence, U.S. stocks, crypto and other risky assets are fluctuating violently, and it’s not too much to use the sound of the wind and the crane to describe the current market.The market’s high sensitivity, in addition to gaming the expected rate cut, is also superimposed on the fear of recession and the worry about the sustainability of the AI narrative represented by INVISTA.
According to the data, the U.S. economy is not in recession, but it is slowing down faster than expected, and the quality of employment is not high.There are many different ways to judge a recession, but a simple and effective indicator is the Sam’s Rule, which basically defines that the U.S. economy is in the early stages of a recession when the three-month moving average of the U.S. unemployment rate has risen by 0.5 percentage points or more from the low point of the past twelve months.If this indicator, the U.S. has entered a recession from July this year (the recession indicator under the SAM rule was 0.53% in July and 0.57% in August), however, including the Federal Reserve in the mainstream institutions do not think that it has entered a recession.
Using the more authoritative NBER recession indicator to observe, there is currently a small retraction in GDP, employment, industrial production, etc. The 3-year retraction is less than 2%, which is much lower than the 5%-10% level of the historical recession period.
Chart: NBER Recession Indicator Still Far From Recession Territory
The labor market is under even more pressure to slow down.The most critical indicator of U.S. employment data is the NFP data (nonfarm payrolls), released by the U.S. Department of Labor’s Bureau of Labor Statistics (BLS).The breakdown of the data over the past three months shows that the manufacturing sector has been a big drag on the data, and is mainly supported by the service sector and the government sector.In addition, the U.S. Department of Labor at the same time in August and September on the previous data for the downward revision, downward revision of the magnitude of the market surprise, according to the revised data, January 2024 to August 2024, the average new non-farmers only 149,000, significantly lower than the average value of 175,000 in 2019.
Chart: Nonfarm payrolls slowed down significantly in the past three months
Looking further at the types of employment, there was also a clear split between full-time and part-time employment, with U.S. full-time jobs continuing to decline both on a year-over-year and year-over-year basis, while part-time jobs increased both on a year-over-year and year-over-year basis.The increase in part-time jobs masks the decline in total employment to some extent, but it also reveals that the quality of the employment data is not as good as it could be.
Chart: Changes in U.S. Full-Time and Part-Time Workers Suggest Poor Quality Employment Data
In terms of unemployment, the rate has risen to 4.3% amidst a flat labor force participation rate, but has fallen back, with the SAMRI continuing to rise.Of particular interest in the unemployment data is the fact that the U6 unemployment rate (a wider-diameter rate, close to the true market-wide rate) has lifted to 7.9%, its highest level since the epidemic, and also in terms of job vacancies, which have fallen more than expected, with the vacancy rate likewise dropping continuously.
Chart: JOTS Non-Farm Job Openings Decline Continuously
Two consecutive months of job market cooling superimposed on the downward revision of the previous employment data, on the one hand, the market rate cut is expected to be significantly strengthened, focusing only on 25bp/50bp; on the other hand, the recession concerns began to rise.
2. How to fall: The game between the market and the Fed, but the data is still key2. How to fall: The game between the market and the Fed, but the data is still key
After the non-farm payrolls data came out on September 6, the market’s performance fully demonstrated the mixed results of the data and the divergence of the market’s consensus; risky assets rose and fell, but ultimately returned to weakness. the August CPI data released on the evening of September 11, although the year-on-year rate fell back to 2.5%, which was lower than the expected value, the core CPI increased by 0.3%, which was higher than the market’s expectation.The overall inflation continued to be structurally differentiated, with commodities, food, and energy continuing to fall, and services still having a strong stickiness. After the data release, the market’s expectation of a 50bp interest rate cut was significantly reduced, and the stickiness of service inflation indirectly indicates that there is no risk of a recession for the time being.
Chart: July-August CPI Breakdown Reveals Inflation Stickiness Remains High, Decline Decelerates
Market worries about recession persist, coupled with the fall in inflation, the intertwining of the two factors, leading to the market on the rate cut is very “entangled”, the main reason is that the current market consensus can not be standardized as well as full of contradictions.If the rate cut 25bp, on the one hand, the price has been very full, the boost to risk assets is limited, and at the same time can not completely reverse the market’s concern about the recession; if the rate cut 50bp, then the market’s concern about the recession will be increased dramatically, which in turn hampered the boost to risk assets.In either case, the direct impact on the market will be a significant increase in the sensitivity of risk assets.
From the Fed’s point of view, in terms of nature, its regulatory approach mainly consists of two tools: market expectation management and monetary policy management.The former relies on shouting, while the latter relies on actual policy tools.At present, although the Fed did not carry out substantive interest rate cuts, but through Powell within a number of officials continue to shout to the outside world, has formed a relaxation of the market expectations, both from the U.S. bond yields and the U.S. domestic market credit rates have responded in advance, and the formation of substantive easing.
Chart: U.S. Bank Credit Tightening Ratio Decreased and Credit Spreads Narrowed
Take the above chart as an example, the ratio of tight lending by U.S. banks decreased significantly, and credit risk spreads synchronized with the decline after August 5, the market easing trend is clear.
Based on the current slower pace of inflation decline, the super-expected slowdown in the labor market and the real easing environment, the likelihood of a 50bp opening on September 18th is starting to decline, and the probability of a precautionary rate cut in the magnitude of 25bp is increasing.Further, in the absence of clear data to prove that a recession is on the horizon or that inflation has fallen sharply beyond expectations, a soft landing remains the baseline scenario for current trading, and the market will remain oscillatory amidst data volatility from events such as a recession, interest rate cuts, and a general election.
3. What are the implications: Crypto risk appetite is uplifted, but a correction is inevitable3. What are the implications: Crypto risk appetite is uplifted, but a correction is inevitable
Even though it is widely expected that the FOMC meeting on September 18th will start a rate cut cycle, risky assets may not necessarily show an immediate upward movement, especially since the process of cryptocurrency regularization since 2024, with the listing of bitcoin and ethereum ETFs in the U.S. and Hong Kong, has not only allowed mainstream funds to start allocating to crypto assets, but also allowed crypto assets to further weaken their standalone market.Crypto assets are more affected by the volatility of broader assets such as US equities and bonds, and the transmission of rate cuts will directly impact the risk-free treasury market, which in turn will affect risky assets (MAGA7, Russell 2000, SP500, crypto assets).
Historically, it is normal for asset volatility to increase during turning periods in the cycle, mainly due to the game of expectation spreads. When the market is priced ahead of time, any change in data will affect the effect of pricing, which in turn affects the rise and fall of assets.
In terms of the different types of rate cuts, previous precautionary rate cuts usually resulted in a bottoming out of risky assets in response to the cuts, followed by a resumption of the upturn (whereas in the case of relief cuts, the probability of asset declines is usually higher), and the bottoming out time usually lasts for a month.
Chart: Risky assets usually fall before rising when precautionary rate cuts are implemented
For crypto assets, as high-risk assets, the linkage with U.S. equities is getting closer and closer. With a more certain interest rate cut and a soft landing, the market’s risk appetite should be slowly rising, but as analyzed in the previous article, we are now in the stage of divergence before the formation of a new consensus in the market, and oscillations are unavoidable, both in U.S. equities and crypto assets.
Chart: Crypto Assets and U.S. Stocks Fluctuate in the Same Direction
In the longer-term scenario, the odds of crypto going up are still high, but volatility will continue to follow the US stock market closely in the coming month, especially before and after the interest rate cut, and volatility will likely increase further.Also of concern is the impact of the U.S. election, which will have a direct impact on the government’s stance on cryptocurrencies, including that of the SEC, which in turn will have a knock-on effect on the market.